Capacit'e Infraprojects (NSE:CAPACITE) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Capacit'e Infraprojects Limited (NSE:CAPACITE) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Capacit'e Infraprojects

What Is Capacit'e Infraprojects's Net Debt?

The image below, which you can click on for greater detail, shows that Capacit'e Infraprojects had debt of ₹2.88b at the end of September 2021, a reduction from ₹3.61b over a year. However, it also had ₹1.53b in cash, and so its net debt is ₹1.35b.

How Healthy Is Capacit'e Infraprojects' Balance Sheet?

According to the last reported balance sheet, Capacit'e Infraprojects had liabilities of ₹9.26b due within 12 months, and liabilities of ₹4.14b due beyond 12 months. Offsetting this, it had ₹1.53b in cash and ₹2.53b in receivables that were due within 12 months. So its liabilities total ₹9.33b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₹12.2b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 0.62 and interest cover of 3.8 times, it seems to us that Capacit'e Infraprojects is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, Capacit'e Infraprojects is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 262% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Capacit'e Infraprojects can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Capacit'e Infraprojects saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Capacit'e Infraprojects's ability to convert EBIT to free cash flow nor its level of total liabilities gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Capacit'e Infraprojects is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. Given our hesitation about the stock, it would be good to know if Capacit'e Infraprojects insiders have sold any shares recently. You click here to find out if insiders have sold recently.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.